Here's what Wall Street will say about Apple's earnings tomorrow
07/18/2011 2:17 pm EST
And I think I can write day’s headlines now: “Apple Beats Q3 estimates, Guides Q4 below Consensus.”
If I’m right, should you sell now and head for the hills? Not a chance. Any dip now would be the kind of buying opportunity that frequently comes with Apple’s quarterly earnings report. The stock has a history of volatility around its quarterly reporting dates. For example, Apple shares hit $345.68 on January 13. The company reported earnings on January 18. And by January 21, the stock was at $326.72. Of course, by February 16 it had rallied to $367.13.
I think this week will bring classic post-earnings volatility to Apple shares—and then some. The signs are pointing to one of those moments when analysts work hard to turn short-term negative noise into long-term negative forecasts.
Should we let the analysts scare us? No.
To say that the 35-plus analysts covering Apple have a horrific track record of predicting earnings would be like saying Apple’s earnings results over the past five years have been okay. (Apple has grown earnings by an average annual 59% over the last five years.) Apple has a history of beating guidance, then providing conservative guidance, and then beating guidance again. You’d think that analysts would have caught on by this time but analysts have underestimated Apple’s earnings for years and this quarter will be no different. For the third quarter analysts are expecting earnings of $5.73 a share; this likely won’t be within 10% of the figure Apple reports next week. Last quarter analysts were off by 19%.
Look at the divergence in analyst estimates for the quarter. Although the average estimate is $5.73, the top estimate is $6.40 and the bottom is $5.10. That puts the high estimate 26% above the bottom estimate. And next quarter shows an even larger divergence. The top estimate is $7.15 a share and the bottom just $5.35, putting the high estimate 37% above the low. (In contrast Microsoft shows a 19% difference bottom to top for its June quarter.)
What’s all the negativity about?
Rumblings among bearish Apple analysts that Apple might be losing share in the key iPhone category and that margins are eroding. This will be the first third quarter period since the iPhone was introduced that a new or updated version has not been released during the quarter. As a result, it is possible that iPhone sales could be lower than the quarter before, also a first.
Big deal? You wouldn’t think so since the iPhone 5 is expected to be out sometime in August or September, right?
But bearish analysts are making the argument that if the iPhone 5 doesn’t comes out until September (instead of August), it might be late enough to miss the back to school buying season and that could make earnings for the fourth quarter, for Apple the quarter that ends on September 30, lighter than expected.
Of course, if that’s your argument, then you’d also have to admit that earnings for the first quarter, the one that ends on December 31, would then have to be higher than anticipated.
But the bearish argument on a potential delay in introduction from August to September fits in with worries that Apple’s margins might face pressure. Margins will already be lower due to the supply chain problems caused by the Japanese earthquake and Tsunami. And then, if Apple has to cut prices so that an older iPhone can compete with new Android phones, margins will be pushed even lower. Or at least that’s how the argument goes.
Again, even if this is correct, these analysts are talking about a short-term problem and trying to make it sound like a long-term downward trend.
To understand why, I think you have to understand how uncomfortable Wall Street is with this stock.
At a current price of $360 a share Apple is priced like a value stock and not one that is forecast—even by Wall Street analysts--to grow earnings 64% this year and another 17% next year. Shares fetch less than 14.5 times this year’s earnings expectations and 12.3 times next years. That’s below the 15.2 multiple on the Standard & Poor’s 500. Based on pure fundamentals, Apple should trade somewhere around 20 times next year’s projected earnings of $30 making shares worth $600.
I think there are three reasons for Apple’s value-stock valuation.
- Health of Steve Jobs. Apple’s CEO took a health-related leave of absence earlier this year and battled a serious form of pancreatic cancer in early 2009. Even though Apple has a strong management team led by Tim Cook and has excelled in his absences, Wall Street can’t stop worrying about “Apple after Jobs.”
- Excessive cash balance. Apple’s current cash balance of $66 billion—in contrast Microsoft’s cash balance was a mere $50 billion at the end of the company’s March quarter--is growing by an average of $7.5 billion per QUARTER. Cash makes up 20% of Apple’s valuation, earns next to nothing in the bank, and leads Wall Street analysts to worry about a large acquisition down the road. They want Apple to pay out some of this cash –either by dividend or share repurchase—and worry about Apple squandering it on a dumb acquisition. But Apple seems to have another reason for not paying out more cash. Most of it—61% and growing--is overseas and cannot be repatriated to the US without paying taxes. Since the whole point of structuring operations to take advantage of low-tax countries—How do you think Google (GOOG) paid an effective tax rate of 19% in its just reported quarter?—is to save on U.S. taxes, repatriating the money to pay dividends would waste a lot of corporate tax planning. Especially since recurrent rumors of a tax holiday whereby companies could return overseas cash while paying taxes at a much lower rate would seem to make waiting prudent.
- Market Cap. With a $322 billion market cap Apple is the second largest company in the US behind ExxonMobil (XOM). The conventional wisdom is that a company this big can’t keep growing earnings this fast. And Wall Street analysts are just waiting for the day when this law of nature kicks in and Apple’s growth reverts to the mean. Of course, Apple’s competition at the top of the market cap list, ExxonMobil is forecast to grow earnings by 43% in 2011, but most analysts see that as a special oil company case that doesn’t extend to a technology company such as Apple. But the low multiples awarded to Apple make this last argument moot. If Apple already trades at a below-market price-to-earnings ratio, then the downside of a drop in earnings growth from 60% to 20% would seem to be already priced into the stock.
I don’t expect Apple to move up to a price-earnings ratio of 20 nor do I expect it to repeat its 42% gain over the past twelve months. I do think that earnings will continue to outstrip analyst estimates and that in the next 12 to 18 months Apple should earn at least $32 a share. With a slight multiple expansion from 14.5 times earnings to 15 times—still below the market multiple--Apple would trade at a price of $480 for a 33% gain from today’s price.
Not quite the returns Apple investors have seen over the past decade but enough so that the shares would outpace the broader market.
This post was reported and written by Peter Butkus. He is an MBA student at the UCLA Anderson School of Management and is interning at Jubak Asset Management this summer.
Full disclosure: I do not own shares of Apple in my personal portfolio. The mutual fund Jim Jubak manages, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of Apple and Google as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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